APAC Realty Limited: Initiation Report

Business Model of APAC Realty Limited

APAC Realty Limited (‘APAC Realty’) operates a leading brokerage under the ERA brand in Singapore. It was listed on SGX on 27 September 2017 with ticker code of (CLN.SI). Its IPO public offer tranche was oversubscribed 29 times. As at 24 June 2018, it has a market capitalisation of USD$220 million. APAC Realty is helmed by Jack Chua and its key management team has an average of approximately 20 years of experience in the real estate industry. Jack Chua has been with APAC Realty for 27 years. As a provider of real estate services, APAC Realty has a simple business model that operates in the following segments:

A) Brokerage

APAC Realty has appointed ERA Realty Network Pte Ltd, a wholly-owned subsidiary, as an ERA Members Broker. This allows ERA Realty Network Pte Ltd to operate as a real estate agency in Singapore under the ERA brand. As at 25 April 2018, ERA has more than 6,100 registered agents. This makes ERA the second largest brokerage agency behind Propnex. It commanded 37.9% market share by transaction value in 2017.

In 2017, the Brokerage division derived revenue from 3 main segments in similar proportions:

The rest of the revenue (5.9%) is derived from commercial resale and leasing. In total, this segment contributed to 97% of the revenue in FY2016.

B) Franchise

By owning the exclusive master franchise rights for ERA brand, APAC Realty is able to sub-franchise the ERA Marks to its franchisees. In turn, APAC Realty will collect royalty fees. Diagram 2 shows the countries which APAC Realty have already established franchise agreements and countries where it has not, but still fall under the regional master franchise agreement.

Diagram 2: Sub-Franchisees Under Regional Master Franchise Agreement

Additionally, APAC Realty also holds the franchise license in Singapore for Coldwell Banker. This segment only contributes less than 0.2% of total revenue in 2016.

C) Training, Valuation and Other Ancillary Services

Through its wholly-owned subsidiary, Realty International Associates, APAC Realty operates training programmes and courses for real estate agents to prepare them for professional certification exams. Realty International Associates is an approved course provider appointed by the Council for Estate Agencies.

In addition, APAC Realty also provides real estate valuation and property management services on behalf of its clients. This segment only contributes less than 2.8% of total revenue in 2016 although it has significantly higher gross margins.

Investment Merits of APAC Realty

1. Improving Track Record

From 2014 to 2017, APAC Realty registered Compounded Annual Growth Rates of 22%, 28% and 24% for its revenue, net profit and net operating cashflow as shown in Diagram 3. 2015 and 2016 can be associated with a slow residential market as the introduction of Total Debt Servicing Ratio resulted in a fall of property prices and transaction volumes.

Diagram 3: Revenue, Net Profit, Net Operating Cashflow of APAC Realty

2. Excellent Return on Equity

The average ROE of APAC Realty also surpasses the 12% ROE benchmark that Heartland Boy sets for all his stocks. APC Realty is also witnessing an improving net margin in 2016 and 2017 as Singapore enters the start of a multi-year residential upturn. However, APAC’s gross margins in 2018 might suffer as a larger proportion of its agents (74%) are in a 90/10 commission split as compared to 71.7% of its agents in 2017. This was a necessary defensive move by APAC to incentivize and retain its agents.

Diagram 4: Operating, Net Margins and ROE of APAC Realty

3. Net Cash Position

As at 31 March 2018, APAC Realty has cash and cash equivalent of $63.5 million and no debt. This net cash position contributes to $0.18/share or almost 21% of market capitalization. (24 June 2018)

4. Dividend Yield

Its trailing dividend yield is 2.4% based on a share price of $0.835. The Board has also indicated in its IPO Prospectus that it intends to distribute 50% of its net profit after tax for FY2018 as dividends. This dividend policy is likely to continue given that its majority shareholder, NorthStar, is a Private Equity fund which may be required to deliver regular distributions back to its investors as well.

Heartland Boy estimates that total Net Profit for FY2018 should be at least $30 million, and this will translate into EPS of 8.4 cents. Assuming a 50% dividend payout ratio, the dividend yield based on current stock price will be 5.2%.

5. Sustainable Competitive Advantage

APAC Realty’s sustainable competitive advantage comes in terms of its size. As the agency with the second largest number of registered agents, it will always be in the consideration of developers during a sales launch. A larger agent network implies a larger outreach, and this gives the developer the highest chance of selling its apartment units quickly. In particular, ERA is well known in the industry as being a market leader in mass market to the middle-high segments. In 1Q2018, its overall market share in private primary and secondary sales and HDB resale was an average 36.3%.

As at end May 2018, ERA has secured a healthy market share of 41.6% for project launches. This is a pipeline of approximately 8,800 units in 14 projects that are forecast to be launched for the rest of the year.

6. Growth Drivers

A) Liquidity Awash In The Singapore Residential Sector

The main reason why Heartland Boy is bullish on APAC Realty is because of the strength of the Singapore residential market. In 2017, en-bloc sales volume was $8.7 billion. In 2018 YTD, en-bloc sales volume has already reached $9.9 billion. Assuming conservatively that 50% of this wealth is re-invested to find a replacement home, that means there is potentially $9.3 billion of liquidity lying around since beginning 2018. (assuming it takes 6 months for the home owners to receive the cash from the developers) It is for this reason that DBS Vickers predicted transaction volumes in the private market (primary and secondary) to reach $52.2 billion and $57.4 billion in FY18 and FY19 respectively. Note that transaction volume was only $28.8 billion and $45.4 billion in 2016 and 2017 respectively. Assuming the ERA franchise maintains its market share in the Singapore residential market, a bigger transaction volume means greater revenue and profit for APAC Realty.

B) Expansion of Geographical Presence

As stated in its strategy during its IPO application, APAC intends to expand its geographical presence via executing more franchise agreements. It has gradually delivered on this strategy. In June 2017, APAC realty entered into a franchise agreement with Eurocapital JSC to grant EuroCapital JSC exclusive rights to operate or grant membership for the operation of ERA Member Broker offices in Vietnam. In February 2018, APAC Realty granted Smart Property Intelligence Co. Ltd exclusive rights to operate or grant memberships for the operation of ERA member broker offices in Cambodia. In March 2018, it has also entered into a partnership agreement with MLN Overseas to provide property buyers from China one-stop real estate services in Singapore, Malaysia and Thailand.

Investment Risks of APAC Realty

1. Large Exposure To Singapore Residential Market

The single and biggest risk to APAC Realty in the short term would be a sudden downturn in the Singapore residential market. APAC Realty generates more than 99% of its revenue from Singapore. For instance, the government can step in with cooling measures that will catch the market off-guard. Rising interest rates will also make financing more inaccessible. Honestly, it is not possible to anticipate what kind of cooling measures that the government can roll out in the near term. What Heartland Boy can do is to monitor the trend of en-bloc sales, as well as transaction volumes and price indexes of the Singapore market. Occasionally, Heartland Boy also speaks to property agents to get a pulse on the consumers’ sentiment.

2. Technology Disruption

In the mid-term, APAC Realty will face competition from disruptive technology that facilitates “Do-It-Yourself” transactions in a real estate transaction. This removes the need of a middle man such as the property agent. According to HDB, the proportion that carries out do-it-yourself transactions is 28% in 2017, up from 11% in 2010. Heartland Boy suspects that more and more people would be willing to embrace such technology to save on brokerage fees. APAC Realty is well aware that this disruption is very real. That is why part of the IPO proceeds will be used to create or acquire new technological capabilities to increase business efficiency and offer better service levels.

3. Termination of ERA Master Franchise Agreement

APAC Realty’s regional master franchise agreement with Realogy for the ERA brand will expire in 2029. Note that APAC Realty has the option to renew for additional 30-year terms on the same terms and conditions provided that it is not in material default of any provisions stipulated in the agreement.

Beyond the loss of license to operate the ERA brand in these markets, APAC Realty will also have to perform an immediate impairment of the goodwill attributed to the ERA brand on its balance sheet. According to its 2017 Annual Report, the intangible assets stand at $100 million. Investors of APAC Realty will have to assess for themselves the long-term risks of such a situation materialising.

4. Declining Share Price Since End March 2018

As show in Diagram 5, APAC Realty has retreated off highs of 1.28 since 27 March 2018.

Diagram 5: Share Price of APAC Realty Has Declined Since 27 March 2018

Interestingly, 27 March 2018 also marked the end of the lock-in period* associated with the IPO. This means that key agents listed in the IPO Prospectus can offload shares of APAC Realty freely. Based on their shareholding, they can also do so without triggering any SGX notifications. However, Heartland Boy’s analysis is that their shareholding is too small to explain for the massive fall in share price since end March 2018. This still leaves Heartland Boy baffled as to why APAC Realty has retreated almost 35% from its all-time high. News on real estate market outlook is generally still positive. Perhaps, the market has already priced in a weak 2Q2018 results which Heartland Boy thinks is a likely scenario. Management had warned that earnings for 2Q2018 is likely to be soft due to lower transactions in 4Q2017 and 1Q2018.

*Do note that Cornerstone Investors are not subject to this moratorium though.

Conclusion of APAC Realty

Real estate is a cyclical play and Heartland Boy is clearly trying to use APAC as a general proxy to ride the rising Singapore residential market. Therefore, he will get out as soon as the cycle is over. This can be judged by falling property prices and falling transaction volumes. Therefore, Heartland Boy does not intend to hold APAC Realty as a long-term play.

At share price of 83.5 cents, APAC Realty has a PE ratio of 9.9 times. Heartland Boy has a personal target price of $1.19 on APAC Realty. Analyst research reports by DBS Vickers and RHB indicated target prices of 1.22 and 1.35 cents respectively.

Vested at an average price of 1.01 cents since April 2018. Heartland Boy would definitely add more but is mindful of portfolio management. He will continue to share his thoughts of APAC Realty on forums such as InvestingNote.